Electronic trading systems provide computer-based platforms for matching buyers and sellers of financial instruments. In recent years, the use of electronic trading systems has revolutionized the industry as traders have increasingly favored electronic trading over traditional trading methods. Electronic trading systems offer many advantages including reduced transaction costs, increased accuracy, expanded trading hours and the wide dissemination of real time market information.
Electronic trading systems are now common in most financial markets. In the equities market, for example, NASDAQ uses an order entry and execution system known as SuperMontage for all securities transactions. In the Foreign Exchange market, Reuters and EBS operate online trading systems. BrokerTec and eSpeed have developed electronic trading systems for the inter-dealer bond market.
Many electronic trading systems receive buy and sell orders from traders and immediately publish the order information to each trader in an order book. This fast dissemination of information poses problems, however, when block trades (trades having a relatively large order size) are involved. For example, when large block orders appear on the exchange's order book, it is common for other traders to respond by taking actions that lead to adverse price movements for the block trader. Many of the difficulties associated with electronic block trading systems are explained in U.S. Patent Publication No. 2004/0059666, published Mar. 25, 2004, and incorporated herein by reference.
One solution to the information dissemination problem is to segment the block order into smaller portions for trading as individual units. Often, only one segment is displayed in the order book at a time, allowing sequential execution of the block order segments without disclosing the block order to other traders. Although other traders will only see the small orders, savvy traders may be able to identify an attempt to execute a large block order in segments, particularly when the segments are relatively large.
Another approach is an “All or None” (AON) order, which is either filled in its entirety or not at all. If an AON order is immediately displayed, the market may be driven away from the AON trader. In another approach, an AON order is not displayed on the order book until enough shares are available to fill the order. When enough shares are available, the AON order is added to the book and the order is executed. In this manner, information regarding a pending AON block order is not disseminated to other traders. One drawback of an AON order is that the order may not get executed while smaller orders continue trading.
In derivatives markets, additional issues arise including the transactional costs of processing trades and a general lack of liquidity for certain derivatives. Unlike securities, over-the counter (OTC) derivatives are bi-lateral contracts which are nonfungible and have significant processing costs associated with each transaction. For example, each option contract owned by a trader will expire unless exercised by the maturity date. The trader is responsible for monitoring the status of the option, deciding whether to exercise the option and taking the necessary steps to exercise the option if desired. As a result, a trader of derivatives typically prefers to execute a small number of large trades, as opposed to numerous smaller trades, to reduce the ongoing processing costs. Electronic trading, however, has led to a decrease in the average trade size as compared to traditional approaches, leading to potentially higher processing and transaction costs.
The traders that bring large block orders to the market seldom want their orders to be filled through a series of very small transactions and generally prefer to maintain their block orders in confidence to avoid price manipulation by other traders. In view of the above, there is a need for a block trading system and method for derivatives and other financial instruments that protects confidentiality of large block orders, provides efficient trading of block orders and reduces associated transaction costs. It is desirable that such a system would, at the same time, support traders that bring smaller volume orders to the same order book.